Government Intervention

Question 1

Redistribution

Answer 1

In order to create economic equality, wealth from the rich is transferred to the poor, usually through tax systems and government spending programs

Question 2

Equity

Answer 2

Equity amoung people (fairness)

Question 3

Efficiency

Answer 3

Deadweight loss from government intervention

Question 4

Equity-Efficiency Tradeoff

Answer 4

The sacrifice of equity for efficiency

Question 5

Okun’s Bucket

Answer 5

The bucket that leaks money (inefficiency of taking money from the rich and giving it to the poor).

Question 6

Social Welfare Function

Answer 6

Utility function for society as a whole

Measures how society weights utility of each person’s welfare and uses weights to combine into a function.

Question 7

Diminishing Marginal Utility of Income

Answer 7

Each additional dollar earned increases marginal utility by a lesser amount than the lost dollar

Question 8

Marginal Benefit of Redistribution

Answer 8

(Marginal Utility of dollar given to the poor) - (Marginal Utility of dollar taken from the rich) = Marginal benefit

Question 9

Which of the following is the most important way that the federal government in the United States currently redistributes income?

Answer 9

The progressive taxation system. A progressive taxation system is one in which people with higher income pay a higher percentage of their income in taxes. That means the rich pay more and the poor pay less, so such a system redistributes income. This system is the primary means through which the US federal government redistributes income.

Question 10

Which of the following programs is most likely to increase income equality in a country?

Answer 10

New job training programs for low-skill workers. Job training programs, especially those for low-skill workers, help those with relatively less income, so they improve income equality.

Question 11

The government creates a new program that taxes income of billionaires and uses the tax revenue to buy food for low-income citizens. This program will most likely ___________.

Answer 11

Decrease income inequality and decrease efficiency. This program takes money from the wealthiest people and gives these resources to the poor. This will decrease income inequality. However, this program is also likely to decrease efficiency. As we saw in the lecture (with Okun’s leaky bucket analogy), taxing income discourages people from working, leading to some deadweight loss and inefficiency.

Question 12

The table below shows Karen’s income over two years and the amount of income tax she paid each year.

Suppose there were no changes in the marginal tax-rate schedule. Which of the following is true of Karen’s tax rates?

Answer 12

The average tax rate when Karen earned $64,000 was lower than her marginal tax rate on the last $14,000 she earned that year. In Year 1, Karen’s average income tax was $10,000 / $50,000 = 20%. In Year 2, Karen’s income was higher. Since we know there were no changes in the marginal tax-rate schedule, this allows us to calculate the tax rate on the extra income she earned. She made an extra $14,000 and paid an extra $6,000 in tax. Hence, the marginal tax rate (or the tax rate on this extra money) is $6,000 / $14,000 = 43%. Her average tax in year 2 is $16,000 / $64,000 = 25%. This means that the average tax rate in Year 2 (25%) is lower than the marginal tax rate on the last $14,000 she earned that year (43%).

Question 13

Suppose County X has a Gini coefficient of 0.5, whereas Country Y has a Gini coefficient of 0.3. Which of the following statements must be true?

Answer 13

Income is more evenly distributed in Country Y. The Gini coefficient is a measure of income inequality. A higher coefficient means more inequality. Hence, since Country Y’s Gini coefficient is lower, it has a more even distribution of income.

Question 14

Which of the following taxes contributes most to increasing income inequality?

Answer 14

Sales taxes on necessities. A progressive income tax and a proportional income tax both mean that the richest pay more than the poorest, decreasing income inequality. Wealth and property taxes have a similar effect on inequality, since rich people have more wealth and more property. A sales tax on necessities, by contrast, is regressive. The poor spend a larger proportion of their income on necessities like food, so if these are taxed, then the poor pay a higher proportion of their income in sales tax than do the rich. Income inequality will therefore increase.

Submit

Question 15

Consider a graph for the entire labor market, below. Suppose that the labor market began at equilibrium with supply curve S1 and demand curve D, but that the government imposes a tax on income, represented by the shift to supply curve S2.

With this new tax on income, what happens to employment?

Answer 15

It decreases. At the old equilibrium, employment was E1 and wage was W1. The new equilibrium is where the new supply curve (S2) crosses demand. At that point, employment is E2, which is lower than E1.

Question 16

Refer to the graph in Question 1A. With the new tax on income, what happens to the income that workers receive?

Answer 16

It decreases. At the old equilibrium, employment was E1 and wage was W1. The new equilibrium is where the new supply curve (S2) crosses demand. At that point, wage is W2. But this is not the wage that the workers receive. Rather, this is wage paid out by the firm, some portion of which goes to the government in taxes. The wage received by the worker is that which corresponds to where the vertical line from the new employment level, E2, intersects the old supply curve, S1. This wage of W3 is lower than the original before-tax wage of W1.

Question 17

Refer to the graph in Question 1A. What regions represent the workers and firm surplus prior to the tax?

Answer 17

Workers: E + F + G + H; Firm: A + B + C + D. Prior to the tax, the wage is W1 and the supply curve is S1. Worker surplus is the area above the labor supply curve and below the wage line (E + F + G + H). Firm surplus is the area below the labor demand curve and above the wage line (A + B + C + D).

Question 18

Refer to the graph in Question 1A. What regions represent the workers and firm surplus after the tax?

Answer 18

Workers: H; Firm: A. After the tax, the wage paid by the firm is W2 and the wage received by the workers is W3. The supply curve is S2. Worker surplus is the area above the labor supply curve and below the wage (W3) line (H). Firm surplus is the area below the labor demand curve and above the wage (W2) line (A).

Question 19

Refer to the graph in Question 1A. What regions represent the government revenue and deadweight loss after the tax?

Answer 19

Government revenue: B + C + E + F; Deadweight loss: D + G. The tax per worker is the difference between the wage the firm pays (W2) and the wage received by the workers (W3). The government gets this revenue for all of the E2 workers who are employed. So the amount of government revenue is (W2 – W3) x E2, or the area of the rectangle B + C + E + F. Deadweight loss is the area of the triangle that used to be a part of the surplus before the tax, between E2 and E1 (triangle D + G). This area represents the lost surplus from labor agreements that would have been made without the tax but are not made with the tax.

Question 20

Market Failures

Answer 20

Occurs when the free market doesn’t lead to the most efficient welfare maximizing outcome (ex: monopolies)

Question 21

Negative Externality

Answer 21

In a mutually beneficial trade between two people (A and B), a negative externality occurs when a third party (person C) is negatively affected by the trade, but neither person A or B bear this cost.

Question 22

Positive Externality

Answer 22

: In a mutually beneficial trade between two people (A and B), a positive externality occurs when a third party (person C) is positively affected by the trade, but neither person A or B get any of this benefit.

Question 23

Social Marginal Cost

Answer 23

Private Marginal Cost + Externalities Cost

Question 24

Suppose a nuclear power plant pollutes a river that serves as a water supply for a city. An economist would argue that pollution from the power plant should be reduced until ___________.

Answer 24

The social marginal benefit of clean water is equal to the social marginal cost of clean water. To maximize total social welfare, pollution should be reduced until the social marginal benefit of the clean water is equal to its social marginal cost. If only the private benefits and costs are being considered, the negative externality of the polluted water will lead to a socially inefficient outcome with lower overall social welfare.

Question 25

Smoking cigarettes causes cancer and health problems both for smokers and nonsmokers who breathe smoke-filled air. If cigarettes prices are determined in a free market, which of the following will be true?

Answer 25

The equilibrium price of cigarettes will be too low and the equilibrium quantity will be too high. This is a classic negative consumption externality. The marginal social benefit will be lower than the marginal private benefit, because cigarettes negatively affect people besides the smoker. This can be represented as a marginal social benefit curve that is shifted to be lower than the demand curve. The free market equilibrium quantity will be too high and the price too low. The price should be higher (for example, through a tax) in order to correct this market failure.

Question 26

Suppose chocolate factories produce a heavenly smell that people living nearby love. Which of the following will be true of the equilibrium quantity of chocolate sold in a competitive market?

Answer 26

Price will be higher than marginal social cost. This is an example of a positive production externality. The social marginal cost is below the private marginal cost since the firm does not factor in the positive externalities from the smell into its private marginal cost considerations. The equilibrium quantity will be too low, and the equilibrium price will be too high (higher than marginal social cost).

Question 27

Which of the following can best be described as a situation with negative externalities?

Answer 27

Daria lives in Boston but flies to Baltimore twice a week, helping her do her job but increasing harmful greenhouse gas emissions. Daria realizes some of the costs of her flights Baltimore (the cost of the tickets, the opportunity cost of her time to travel, etc.) but not all of them, including the increased greenhouse gas emissions that negatively affect the environment and others living in it. Because these costs to others are not internalized by Daria in her travel decisions, they are considered negative externalities.

Question 28

Production Externality (Supply-Side Externality)

Answer 28

Externalities that arise from the process of production

Question 29

Consumption Externality (Demand-Side Externality)

Answer 29

Externalities that arise from the process of consumption

Question 30

Suppose there are positive externalities in the market for measles vaccines, since one person getting a vaccine helps protect people who are not vaccinated. Which of the following is most likely to be true?

Answer 30

If the government offers a small subsidy on vaccines, the equilibrium quantity of measles vaccine will move closer to the socially-efficient quantity. There is a positive consumption externality to the measles vaccine, so the free market equilibrium quantity will be too low and the price too high. A government subsidy to the vaccine makers (or to the consumers of the measles vaccine) will increase the equilibrium quantity and lower the price, moving both closer to their socially-efficient values.

Question 31

A policy that completely bans pollution in an industry will improve efficiency if which of the following is true?

Answer 31

The marginal cost of the ban is lower than the marginal benefit of the ban. If the marginal cost of the ban is lower than the marginal benefit, enacting the ban is certain to improve efficiency: social welfare will be increased by exactly the difference between the higher marginal benefit and the lower marginal cost.

Question 32

The graph below shows the market for literacy education, which helps ensure that people know how to read at a basic level.

Which of the following is true, based on the graph?

Answer 32

The quantity of literacy education in the free market will be too low. This is an example of a positive consumption externality. Those who learn how to read benefit people who are not part of the transaction. Therefore, the quantity of literacy education will be too low in a free market (and the price will also be too low).

Question 33

Suppose that the marginal social cost of producing a good is higher than the marginal private cost, and the marginal social benefit is lower than the marginal private benefit. Which of the following government actions is most likely to increase efficiency?

Answer 33

Taxing firms that produce the good. This is an example of both a negative consumption externality (marginal social benefit is lower than marginal private benefit) and a negative production externality (marginal social cost is higher than marginal private cost). Both of these result in an equilibrium quantity that is too high, and a tax on the firms producing the good will help to lower the quantity produced.

Question 34

The graph below shows marginal cost and benefit curves, both social and private, for a certain good. The vertical axis is in dollars and the horizontal axis is the number of units of the good.

Based on the graph above, this good is one which has a ___________.

Answer 34

Negative consumption externality. A negative consumption externality is characterized by a marginal social benefit that is less than the marginal private benefit, as seen in the graph. Note that a negative production externality is characterized by a marginal social cost that is greater than the marginal private cost.

Question 35

Refer to the graph in 5A. What is the socially optimal quantity, and what is the level of the tax the government should impose to achieve that quantity?

Answer 35

Quantity: Q1; Tax: P3 – P1. The optimal quantity is that at which marginal social benefit equals marginal social cost, namely Q1. To achieve a quantity of Q1, consumers must pay P3 and producers must receive P1, so the optimal tax should be the difference, P3 – P1.

Question 36

Regulation

Answer 36

When the economy is controlled, usually by the government, in order to achieve social optimal outcome

Question 37

Taxation

Answer 37

Tax on externality

Marginal cost increases by that tax

Question 38

Health Externalities

Answer 38

Individuals decisions that affect other people’s health